Stiglitz: A Year After Lehman, Banking Problems Are Bigger

In an interview today in Paris, Nobel Laureate Joseph Stiglitz said that while the Obama Administration has managed to stave off the collapse of the banking system, it has also failed to address the underlying problems of the banking system. He further adds that the Obama Administration is "very reluctant to do what is necessary."

From Bloomberg News:

"In the U.S. and many other countries, the too-big-to-fail banks have become even bigger," Stiglitz said in an interview today in Paris. "The problems are worse than they were in 2007 before the crisis."

Stiglitz's views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama's administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing "excessively."

A year after the demise of Lehman forced the Treasury Department to spend billions to shore up the financial system, Bank of America Corp.'s assets have grown and Citigroup Inc. remains intact. In the U.K., Lloyds Banking Group Plc, 43 percent owned by the government, has taken over the activities of HBOS Plc, and in France BNP Paribas SA now owns the Belgian and Luxembourg banking assets of insurer Fortis.

While Obama wants to name some banks as "systemically important" and subject them to stricter oversight, his plan wouldn't force them to shrink or simplify their structure.

Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action.

What is necessary is breaking up the banks, separating ancillary business from core banking functions as well as increased regulation. Post the collapse of the Lehman Brothers that set off the financial meltdown, there has been a marked consolidation in the US banking sector. The four largest banking companies now control more than 40% of the nation's deposits and more than 50% of the assets held by United States banks.

A principal worry is that the Obama Administration is failing to address the systemic risk caused by the creation of giant nationwide franchises overlapping and competing with each other in various local markets.

It is also of concern that some new "innovative" securities seem more apt for a Las Vegas casino than they do for a bulge-bracket Wall Street investment bank. The time has come to rein in the process known as securization. Moreover, banks that perceive themselves as "too big to fail" continue to engage in questionable practices taking on excessive risk because should they fail the government will act to prevent their collapse.

This dilemma of "too big to fail" was addressed by Federal Reserve Chairman Ben Bernanke during a March 2009 speech at the Council on Foreign Relations: "Authorities have strong incentives to prevent the failure of a large, highly interconnected financial firm, because of the risks such a failure would pose to the financial system and broader economy...However, belief that a particular firm is considered too big to fail has many undesirable effects." Chairman Bernanke noted that such a belief reduces market discipline and encourages excessive risk-taking by larger institutions, provides an artificial incentive for firms to grow, in order to be perceived as too big to fail, and creates an unlevel playing field with that of smaller firms, which may not be seen as having implicit government support.

Professor Stiglitz, the former chief economist for the World Bank and former member of the White House Council of Economic Advisers who now teaches at Columbia University, also noted the world economy is "far from being out of the woods" even if it has pulled back from the precipice it teetered on after the collapse of Lehman.

More from Bloomberg:

"We're going into an extended period of weak economy, of economic malaise," Stiglitz said. The U.S. will "grow but not enough to offset the increase in the population," he said, adding that "if workers do not have income, it's very hard to see how the U.S. will generate the demand that the world economy needs."

The Federal Reserve faces a "quandary" in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said.

"The question then is who is going to finance the U.S. government," Stiglitz said.

I remain cautious on the near-term economic outlook expecting a jobless recovery with GDP demonstrating anemic but positive growth in the second half of 2009. However there remains significant risk of a "double-dip recession" as the economy fizzles from a lack of investment. Furthermore as NYU economist Nouriel Roubini warned last month, global policymakers face a "damned if they do and damned if they don't" conundrum in trying to unwind their massive fiscal and monetary stimuli to keep the global economy from toppling into a depression.

Another worry is that that energy (the price of natural gas has surged 60% since Labor Day), food and oil prices are rising faster than the fundamentals warrant. Excessive liquidity may be creating artificially high demand. Another bubble may prove devastating to the world economy.

Lastly as per who is going to finance the US government, that may remain an open question. We know who it won't be. It won't come from American savings. The urgency of tackling the deficit is certainly a looming eleven trillion dollar gorilla but with unemployment likely to surpass 10% by year's end the necessity of a second stimulus remains extant. If US policymakers try to fight rising budget deficits by cutting spending prematurely, they will undermine any nascent recovery.

Tags: economics, European Union, Financial Sector Reforms, Joseph Stiglitz, Obama Administration, US Banking Sector, US Economy (all tags)

Comments

3 Comments

Audit the Fed

No what is needed is an audit of the Fed and the resignaton of Bernanke and Geithner for their direct involvement in the scandal that was TARP and their fleecing of the American public by their incestous relationship with the Financial industry.

by BuckeyeBlogger 2009-09-13 06:22PM | 0 recs
There are two issues

and they are related in some ways.

1.  There is an enoumous glut of savings in this World.  This has created an unending series of bubbles in various asset markets from housing to the stock market to oil.  Figuring out how to prevent these bubbles from forming without throwing the economy into a recession remains a problem that I have heard no real solution to.

2.  The size of the large financial firmsmay to some degree be dictated by global economies of scale yet their size creates enourmous systemic risk.  This risk is compounded by the tendency to create asset bubles and by the political power that makes these firms very difficult to regulate effectively.

Breaking these institutions up makes sense.  

by fladem 2009-09-14 06:29AM | 0 recs
Another Stimulus?

We've really been in "stimulus" mode since 2002 and look at the results? Throwing more good money after bad just extends the same problems out a little further.

The only way to get rid of bad debt is to pay it off or default it. Banks are trying to earn their way out of this mess by hitting up the consumer with more fess and higher rates, but that just makes the consumer spend less and increases the mortgage default rate (and each default makes the banks realize values on these assets 20-30% lower than they are currently valuing them on their balance sheet).

That is why bank failures will continue and another stimulus will do nothing to stop it. (Especially if the stimulus project are like a recent project near me to erect a sound barrier near a bocce ball court so they don't bother the neighbors.)

by tpeichel 2009-09-14 07:34AM | 0 recs

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